State of the Azerbaijani Economy Before and After Independence

CHAPTER II: AN OVERVIEW OF THE AZERBAIJANI ECONOMY AND THE COUNTRY'S NATURAL RESOURCE STRUCTURE

2.1 State of the Azerbaijani Economy Before and After Independence

In the twentieth century, the more extensive and vaster rise of the Azerbaijani economy coincided with the Soviet era, which covers more than 70 years. During these years, most of the Azerbaijani economy has grown rapidly and complexly and has a strong industrial potential compared to previous periods. The share of Baku in the industrial production of the country decreased by 11%

in 1985 compared to 1970 due to the development in other regions of Azerbaijan since the 1970s.

The products purchased by the country were imported in the other republics of the USSR instead of domestically manufactured in the USSR, as well as from the import of raw materials to Azerbaijan. This type of planning made countries dependent on each other.

Although the revenue generated from the sale of these products was collected in a single center, the country did not have the right to own property in its own resources. The development of the Azerbaijan economy in the USSR over the last 20 years has not been a stable period. For example, while the average economic growth rate in the country during the 1960-1970 period was 5.2%, it increased to 7.4% from 1970 to 1980. Between 1980-1990, a sharp reduction trend is noteworthy. In the economy, an average decrease of 4.9% was observed in the years 1981-1985 and a decrease of 5-6% in the 1986-1990 period. Prioritizing areas such as natural resources, energy sector based on more intensive use of cheap and abundant labor, economic the structure has created a suitable environment for the crisis. After the collapse of the USSR, the problems that the planned economy has inherited to the national economy are listed below.²⁴

1. Greater regional differences. This situation began to emerge from the first years of the USSR.

90% of the companies that supplied other production and raw materials were in Baku.

2. Both the quality of the goods produced and the per capita amount were below the average of the USSR. For example, in the early 1990s only 50% of the consumption in Azerbaijan was obtained from domestic production.

24 Muradov, Elman (2012). Comparative Analysis of Regional Development Policies of Azerbaijan and Germany. Nigde University Journal of FEAS, 5 (1): 103-115.

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3. The fact that the economic structure was significantly dependent on the USSR left the country in a difficult position immediately after independence.

The main task of the post-Soviet countries is to move from the old, economically inefficient system to a complete market economy. It is possible to divide the economic development up to three main stages since independence. The first phase covers the period of 1991-1995 and this period is the period of collapse. The second stage, 1996-2003 macroeconomic balance period. The third phase began in 2003 and continues so far. As mentioned in the table 1, the formation of the economy in the early stages was aggravated by political and military events. Until 1995, the price of food products increased during the liberalization process: in 1991 it increased by 2.07 times, by 10.12 times in 1992, by 12.3 times in 1993 and by 17.65 times in 1994 compared to the previous year. The table below shows the annual FDI (Foreign Direct Investment) inflows for the period 1995-2017 and their percentage distribution in the oil and other sectors. Starting in 1995, 65% of foreign investments turned to the oil sector. The total amount of foreign capital invested in 2016 was 10161.1 million dollars and 55.3% of the total direct investments were made in the petroleum sector.²⁵

Table 1. The investment amounts over the period of 1995-2017

Years

25 Petroleum Revenues of Azerbaijan, Baku, Ministry of Finance Publications, 2017

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Table 1. The investment amounts over the period of 1995-2017

2005 4893.2 3799.9 77.7 1093.3 22.3

2006 5052.8 3422.3 67.7 1630.5 32.3

2007 6674.3 4003.3 60.0 2671 40.0

2008 6847.4 3350.7 48.9 3496.7 51.1

2009 5468.6 2412.7 44.1 3055.9 55.9

2010 8247.8 2955.3 35.8 5292.5 64.2

2011 8673.9 3407.8 39.3 5266.1 60.7

2012 10314 4287.8 41.6 6026.2 58.4

2013 10540.9 4935.2 46.8 5605.7 53.2

2014 11697.7 6730.7 57.5 4967 42.5

2015 10719.1 6622.7 61.8 4096.4 38.2

2016 10161.1 5617.4 55.3 4543.7 44.7

2017 9976.2 4900.8 49.1 5075.4 50.9

Source: Azerbaijan state statistical committee

Economic recovery was supported by an extremely high level of capital investment as a result of foreign direct investment in the oil sector. 77.8 billion dollars directed to the economy of Azerbaijan in 2000-2017. 66.8 USD bln of foreign direct investment or 85.9% were put in the oil sector, while remaining 19.9 bn. dollars (14.1%) in non-oil sectors. The amount of direct foreign investment in the oil sector over the years is always higher than the non-oil sector.

The interest of oil companies in Azerbaijan begins in 1989 when the president of Ramco S.Rimp came to Baku. With this, the new history of Azerbaijani oil began, and Baku oil attracted the attention of Western investments as in the beginning of the century. After that, representatives of the Pennzoil, BP/Statoil, Amoco companies came to the country and negotiations began. These negotiations resulted in the signing of oil agreements. However, in accordance with the agreement, negotiations in London in June 1993 could not be realized due to the emergence of military-political crisis in the country in the same month of 1993. Between 1991 and 1993, no strategic investment project could be realized due to the current turmoil in the country. After the establishment of permanent and relative stability in Azerbaijan after 1993, the oil negotiations were resumed. On September 20, 1994 the contract containing the joint development and production sharing of Azeri, Chirag and Gunashli (deep water) fields in the Azerbaijani sector of the Caspian Sea was signed, which was later called the Contract of the Century. According to this agreement, oil fields namely - Azeri, Chirag, Gunashli were planned to develop. In fact, within

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this agreement Azerbaijan government gained a chance to develop relations with Western countries and in this way to avoid from Russia pressure. As a result of the contract, a consortium was created and the participant were followings: SOCAR (Azerbaijan) with 20% share, BP (UK) with 17.127% share, Amoco (USA) with 17.01% share, Lukoil (Russia) with 10% share, Pennzoil (USA) with 9.82% share, Unocal (USA) with 9.52% share, Statoil (Norway) with 8.563% share, McDermott International (U.S.) with 2.45 %share Ramco (Scotland) with 2.08% share, Turkish State Oil Company (Turkey) with 1.75% share, Delta-Nimir (Saudi Arabia) with 1.68% share.

This consortium was named Azerbaijan International Operating Company (AIOC). These 28 contracts based on PSA (Production sharing Agreement), which means that oil company cover the costs of exploration and mining, then compensating its expenses from profit. The government can control whole property under the contract after finishing of the repaying period. 80% percent of oil revenues were received by Azerbaijan and 20% of the oil revenues were separated by countries in terms of the contract. In 1999, significant event was happened among participated companies.

Firstly, BP bought the USA Company AMOCO and increased its share in consortium to 34% and became operator of the project. Then, Lukoil sold its shares to Inpex (Japan) company, as a result share of companies slightly changed. Initially, reserves of these contracted oil fields were estimated approximately 511-640 million tons. Whereas, in 2007 it was accounted again and announced that oil reserves in Azeri-Chirag-Gunashli fields were 1 billion tons. On the other hand, quality of Azerbaijan crude oil is considered one of the lightest oil in the world. The second PSA was signed with Western countries to develop Shah-Deniz field in 1996. Initially, big amount of oil reserves was expected from this field, after exploring significant volume of gas reserves were found. Overall reserves were estimated at 1.2tcm of natural gas and 240mln t of gas condensate.

BP, Statoil, Iranian OIEC, Russian-Italian joint company and TPAO were participated in new created consortium. The big share belongs to BP (25.5%) and Statoil (25.5%), Iranian and Russian companies and SOCAR follow them with 10% share for each. TPAO (Turkey) with 9% share also participates in this consortium. This field was one of the important projects for Europe, because its geographical nearness makes transportation easy with comparing to other Eurasia fields. All resources of Azerbaijan belong to the state according to the constitution and management of energy resources controlled by SOCAR. According to the Presidential Decree No. 200, SOCAR was

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created in September 1992 as a result of merger of two big Azerbaijan State companies, there were Azerneft and Azneftkimiya.²⁶

Table 2. Some economic indicators, 1995-2002

Indicators Years

1995 1996 1997 1998 1999 2000 2001 2002 GDP (million dollars) 2415.2 3180.8 3960.7 4446.4 4583.7 5272.8 5707.7 6235.9 GDP per person

(dollars)

310.3 416.1 513.2 570.6 582.9 662.9 710.5 768.9 Unemployment rate

%

4.6 4.5 6.7 7.2 5 11.8 11 10

Inflation rate % 411.76 19.8 3.67 -0.78 -8.5 1.8 1.55 2.78 Gini coefficient 0.459 0.458 0.462 0.462 0.506 0.501

Source: Azerbaijan state statistical committee

In 1991, GDP in the country was 2.7 billion manats (1 US dollar equals 16 Azerbaijani manats). The salaries of workers, which are indicative of the standard of living, have actually decreased by 3.6 times. In 1994 inflation reached its highest point - 1763.5%. Almost all the main indicators of the economy tended to decline in the 1991-1995 period. False reforms and other unsystematic economic arrangements during this period have had negative consequences: the financial and banking system was shaken, budget deficits have risen. In 1994, the interest rate of the Central Bank reached 250%, the national currency manat began to depreciate, foreign trade volume decreased by 42%, until 1994, the Azerbaijani economy was closed to foreign investments.

Compared to 1990, the production volume of the industrial sector decreased by 30% in 1995, while the mining industry decreased by 53%, the manufacturing industry by 28%, and the supply of electricity, natural gas and water decreased by 64%. All these have had negative effects on other industrial sectors.

In 2002, the share of private sector in GDP was 72%, industrial production was 50% and agriculture was 99%. More than 3 thousand new facilities were opened in 2003. The successful implementation of new programs in 2001 led to the creation of 94,000 new businesses and 35,000 new enterprises, which accounted for 96.3% of the private sector. In a short period of time, oil revenues played a major role in increasing the state's budget. At the same time, in the period 2000-2008, government expenditures increased 10 times: from $ 965.5 million to $ 11.9 billion. These

26 Aras, O. N. (2003). Economics of Azerbaijan. Baku: Eastern-Western printing house.

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costs were not for the development of the human factor (education, health, science) but for infrastructure, security and government regulations. Despite the growth of absolute demonstrators, the share of social expenses allocated from the budget was gradually decreasing. For example, while the share allocated to social security in 2003 was 18.2% of all expenditures, it decreased by 9.7% in 2008. Education costs decreased from 23.7% to 11.6% and health services from 5% to 4.3%. Social expenses have increased in absolute terms and this has led to an increase in oil prices and budget. However, the share of relative social expenses has decreased.

In the period of 2014-2018, it was easy to display the result of the fall in oil prices to the exchange rate of Azerbaijan national currency manat (AZN). The variations in oil prices affected the Azerbaijani economy due to the depreciation of the manat. Since a large portion of the country's revenue comes from oil and natural gas sales and diversification of the economy have occurred in times of high oil prices, leading to economic problems at low oil prices. In fact, the decrease in oil prices in the world market directly affects the exchange rate of the manat because this process creates a balance of goods deficit in the balance of payments of Azerbaijan. The exchange rate of the Azerbaijani manat increased sharply in February and December 2015, as the result of two sharp devaluations. Due to devaluation, the manat lost almost half of its value and had the worst currency ever at the end of 2016. The exchange rate of manat continued to rise in February 2017, increasing the US dollar to 1.92. However, nowadays, the downward trend of manat is recorded as 1.70 against the US dollar.²⁷

The change in the policy of the Central Bank of the Republic of Azerbaijan (CBAR) from a fixed exchange rate from floating currencies has a significant impact on the stabilization of manat. In addition, some institutions, such as the Central Bank of the Central Asia and the State Oil Fund of the Republic of Azerbaijan (SOFAZ), began to participate in foreign exchange auctions to prevent further depreciation of the Azerbaijani manat. The price of oil in the world market affects the rate of manat and the economy of Azerbaijan in general. Considering that a significant portion of the country's exports and revenues come from oil and gas sales, the relationship between oil price and manat rate becomes clear. Low oil prices have a negative effect on the balance of payments of the country, which reduces the trade balance. Therefore, the trade deficit leads to an increase in the exchange rate. As a result, the main suppliers of foreign

27 The Central Bank of the Republic of Azerbaijan, AZN Rates, 2017 https://en.cbar.az/other/azn-rates

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currencies such as the Central Bank of Russia and the State Oil Fund of Azerbaijan begin to sell foreign exchange reserves in auctions to prevent further depreciation of manat. As a result, this leads to the rapid depletion of strategic foreign exchange reserves that lead to economic difficulties in the country. The highest price of Brent crude oil in 2014 was $ 114.25 per barrel and then fell sharply until the end of the year. By the middle of January 2015, the price was $ 45.13 a barrel.

As this is a long-term process, the impact of falling oil prices on manat was only seen after February 2015. As a rule, oil prices fluctuated in 2015 and 2016, followed by a significant decrease in 2016. On March 16, 2015, the price of oil was $ 52 per barrel and exceeded $ 64.93 in two months and then fell sharply again in a year. As a result, the exchange rate of manat increased to US $ 1.55 per manat, and on February 21, it was US $ 1.05 per manat. These fluctuations became even sharper in 2016. At the beginning of the year, oil price fell to its lowest level on January 18, 2016 at $ 28.55 a barrel, but doubled in the last month of the year to reach the US dollar. 56.82 barrel. In 2016, the average price for Brent oil was $ 43.73 per barrel, the lowest annual price since 2014.²⁸ As a result, the manat faced difficulties in the global market; however, starting from the last three months of 2016, the rate of the manat started to decrease, reaching 1.7707 against the US dollar in the end of the year.

Figure 1. The effect of Oil Prices on the national currency of Azerbaijan ²⁹

Source: Azerbaijan State Statistical Committee and Central Bank of Azerbaijan

28 BP, Statistical Review, 2016 https://www.bp.com/en/global/corporate/energy-economics

29 Macrotrends and the Central Bank of the Republic of Azerbaijan, 2017

0 20 40 60 80 100 120

0 0.5 1 1.5 2

oil price AZN/USD CR

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In 2017, there was no significant change in oil prices in the world market. On November 6, 2017, there is a growing trend, with a maximum of $ 64.27 per barrel. By November, the lowest oil price was fixed in June and was $ 44.82 per barrel. The overall decline in oil prices in 2016 affected the manat rate at the beginning of 2017, especially in February, when the manat rate was the highest in February, rising to US $ 1.92 per manat. However, the manat was then fixed at 1.70 against the dollar.

Figure 2. Dynamics of rate of the Azerbaijani manat, USD/manat

Source: The Central Bank of the Republic of Azerbaijan, 2020

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